For more information about Vanguard funds, visit vanguard.com or call 877-662-7447 to obtain a prospectus or, if available, a summary prospectus. Investment objectives, risks, charges, expenses, and other important information about a fund are contained in the prospectus; read and consider it carefully before investing.

Vanguard ETF Shares are not redeemable with the issuing Fund other than in very large aggregations worth millions of dollars. Instead, investors must buy and sell Vanguard ETF Shares in the secondary market and hold those shares in a brokerage account. In doing so, the investor may incur brokerage commissions and may pay more than net asset value when buying and receive less than net asset value when selling.

Investments in bond funds are subject to interest rate, credit, and inflation risk.

Diversification does not ensure a profit or protect against a loss.

Investments in stocks or bonds issued by non-U.S. companies are subject to risks including country/regional risk and currency risk. Stocks of companies based in emerging markets are subject to national and regional political and economic risks and to the risk of currency fluctuations. These risks are especially high in emerging markets.

All investing is subject to risk, including the possible loss of the money you invest.

Depending on your age, Halloween conjures many images—some sweet, some scary. My girls are young and seem to experience both extremes: They love the treats but could do without some of the scarier imagery. As adults and investors, we’re not immune to the sweet and scary, and as much as we love to see our portfolios grow over time, we must occasionally face our own fear: rebalaphobia1, or the fear of rebalancing.

Recent returns in the global equity markets have been tremendous. For the five years ended September 30, 2014, global equities gained a cumulative 97.2%, while global bonds gained 26.0%*. Although both asset classes posted sweet returns, the very large difference in returns resulted in a meaningful increase in the equity holdings in many people’s portfolios. For example, Figure 1 shows a globally diversified portfolio of 60% stocks and 40% bonds² established at the beginning of 2009. Thanks to the stock market’s gains following the recovery that began that March, by year-end equities made up 65% of the portfolio. That’s a pretty significant increase in equities, given their historical volatility. Based on our rebalancing research, we feel that most investors should review their portfolio annually and rebalance if an asset class’s weight is 5 percentage points or more out of line with the original, strategic asset allocation.

Historically, a 60/40 portfolio like this would have required rebalancing about every four years using this “5% rule.” It really doesn’t require much time or even attention to rebalance. So why the phobia? Given the return patterns I mentioned above, the need to rebalance typically occurs when stocks have dramatically outperformed bonds and we fear they might continue to do so. Rebalancing ‘too early’ means leaving some gains on the table. It also means that we’d need to add to our bond allocation using the proceeds from our stock sales. I don’t know if you’ve heard, but at today’s yields, bonds aren’t necessarily the most popular asset class around.

So, rebalaphobia is a common problem for investors, who often dislike selling their better-performing assets to buy more of what hasn’t done well in their portfolios. On the surface, this fear seems reasonable, because the future is uncertain and the outperformers in the portfolio could continue to outperform. This is, however, far from a foregone conclusion. The truth is that there never is a perfect time to rebalance when you use higher returns as your measuring stick for success. Rebalancing is important, same as it ever was, but it is a discipline designed to manage risk rather than maximize return.

As we move toward the end of 2014 with the stock markets at historically high levels, the choice to rebalance—at least for some people—may still seem frightening. To be honest, I often feel the same way, and I think that’s just human nature. As Figure 1 also illustrates, while equity allocations drifted to high enough levels in 2009 and 2013 to warrant rebalancing the portfolio, the equity markets didn’t dramatically sell off thereafter. We all fear making the wrong decision, and overcoming rebalaphobia is often as much an emotional challenge as it is an investment decision. However, on one decision I can feel 100% confident: Until the future is certain, diversification, asset allocation, and rebalancing will be the cornerstones of my portfolio.

I would like to thank my colleague, Donald Bennyhoff, for his contribution to this blog.

¹Of course, rebalaphobia is not a medically recognized affliction, but we’re working hard to change this obvious oversight.

²This illustration is for a globally diversified 60/40 portfolio. Non-U.S. equities were given a weight of 30% total equities, with non-U.S. bonds making up 20% of the total fixed income allocation.

Please remember that all investments involve some risk. Be aware that fluctuations in the financial markets and other factors may cause declines in the value of your account. There is no guarantee that any particular asset allocation or mix of funds will meet your investment objectives or provide you with a given level of income.

Colleen Jaconetti

Colleen is a senior retirement strategist in Vanguard Investment Strategy Group. She leads a global team that's responsible for conducting research and providing thought leadership on retirement topics. Colleen specializes in retirement planning, spending, and wealth management strategies. Prior to her current role, Colleen worked as a financial planner in Vanguard's advice department. Colleen earned a B.A. and an M.B.A. from Lehigh University. She is a Certified Financial Planner™ professional and a Certified Public Accountant.

Comments

Richard G. | March 5, 2016 2:18 pm

Well Folkes about this automatic rebalancing problem.It would be extremely hard to institute a “one size fits all” program.Most clients of Vanguard have multiple sources of income separate and apart from their Vanguard balances.For any client who had a substantial part of their portfolio invested or generated apart from there Vanguard acct. then I could see a problem getting their whole program in balance only balancing what was inside Vanguard. You have to remember there are some well healed dudes and dudettes in Vanguard. Multi-Millionaires who may or may not have the major portion of there investments at Vanguard.For them rebalancing only a portion of their investment within Vanguard will not help them in keeping tabs on their whole portfolio.However if you are talking about a client whose whole portfolio is at vanguard and he has a written asset % filed with Vanguard then you might be looking at something that could be done.However you must also realize that people change there asset mixes periodically and emergencies do occur so that they are forced or do not want to rebalance automatically.There just seems to me a whole lot of thought that would need to go into this before it could come to fruition.That’s my 2cents worth. Good Luck to All!

Richard G. | September 14, 2015 4:53 pm

Well fellow rebalancers I am going to bring up one big gorilla to the room.Some of you bloggers are talking about rebalancing taxable income streams of money. Some of you are talking about tax sheltered IRA,401k,Roth money.Some of us only have one good sized IRA to rebalance before age 701/2. Some of us went the other way and we are heavy into the Roth arena and have already paid the taxes and do not have to worry about the taxes owed on the profits.Some Vanguardians have a huge 401k or IRA balances and have to learn how to take out RMD money and balance this money that they already have in the taxable arena. Now you know why Vanguard would be a little reluctant to tackle this rebalance question with all of the myriad accounts,reits,rental income,commercial property owned,insurance payouts and many other types of income investors have. What do you include or exclude in the rebalance?What is one investor strengh($4,000,000.00 in their IRA) might be another investors weakness( their broke,have no retirement but they just inherited a 30 unit apt. complex making $500,000/yr.. On and on it goes. I do not look forward to the RMD payouts as far as it compounding the rebalancing you have with everything taxable compared to the tax sheltered.So get ready to do it yourself with Vanguard crews help.Also another little tid-bit you get to tell Vanguard what account that you want your RMD money taken out of.I would take it out of whatever has gone up or had a lot of appreciation first.

Don L. | December 9, 2014 10:44 pm

There’s a lot of research that indicates that financial market returns, particularly equity market returns, exhibit autocorrelation. That’s a fancy way to say that a positive-return year is more likely to be followed by another positive-return year than a negative-return year, and a negative-return year is more likely to be followed by another negative-return year. What this may mean is that if you rebalance too frequently, you may be more likely to forego some gains by not fully participating in a multi-year bull market, and sustain greater losses in a bear market by buying into it at all stages.

For this reason I think Vanguard’s 5% rule for rebalancing has merit. It seems to be a nice compromise between timely rebalancing to facilitate “buying low and selling high” and retaining your selected risk preferences, and the above-cited evidence of auto correlation of market returns. Their simulation with a 5% rule shows rebalancing every 4 years on average which can be compared to the 3-year bear market of 2000-2002 and the 5 1/2 year bull market of 2009-2014. However, this is NOT meant to be by any stretch a market-timing rule!

Jim M. | December 5, 2014 12:10 pm

If the initial portfolio distribution/rebalancing target were able to be set scientifically according to goals, risk tolerance, and time horizon, it could be published in a table. If the review interval/deviation percentage (or amount) were able to set scientifically, their superiority as to return maximization/risk minimization could be demonstrated
using historical information. But neither of these has been done. So the concept of rebalancing remains an art, subject to oracular pronunications by members of the high priest class. Except maybe for Vanguard and a few others, rebalancing does generate activity which equals expense which equals broker income and taxes.

Right now, bonds and stocks are both “expensive” so reshuffling from the latter to the former may not do much to reduce risk. Unless one can guarantee that the Fed posture will remain fixed indefinitely. Cash is the only major class doing poorly, so gains from any rebalancing should be directed there. Which is exactly what the wealthiest are reportedly doing: some studies a cash component in the range of 25%.

Mary T. | December 5, 2014 11:38 am

My husband and I have been “unbalanced” for several years. I can buy into the diversified stock/bond theory but cannot understand why anyone would buy onto bonds during the ongoing period of low interest rates and so-called quantitative easing. It would seem that the only prospect would be for the value of the bonds to go down. What am i missing here?

Richard G. | March 2, 2016 12:49 pm

To Mary T. 12- 5, 2014 You made a statement that you and your husband have been unbalanced for years.You were asking the question about why would some one buy bonds when every thing pointed to the Fed raising rates on the future. I am writing this blog in 3-2016 and now I know when the rates finally did go up and guess what I did with my bonds-nothing. Sometimes we suffer from” tunnel vision” and only look at a single segment of our portfolio.Vanguard has preached diversify for about 40 years now.I do not buy bonds only for their return but also as a diversifyer.They usually go up when a lot of the market is going down.They can act as a floor for your portfolio and help smooth out any “corrections that may come down the pike.Middle of the road investing has a lot going for it.Investing is a lot more than stocks/bonds/cash.Being debt free as a nice ring to it.Having a good medical program for you and your family is important. Keeping a sizeable savings account in you taxable bank or credit union is another great perk to have in retirement.Vanguard has allowed my family to retire 8 years early.I will always have bond exposure as this is one of Vanguard’s tenants. Good Luck in your program Mam!

Richard I. | December 4, 2014 6:53 pm

I confess to being reluctant to rebalance my portfolio. I am very satisfied with my portfolio’s overall performance and probably should reduce equities. One reason I hesitate is the tax consequences of selling funds / stocks that have significantly increased over the years. I will turn 70 1/2 years old in 2016 and will have to begin drawing down on the tax deferred portion of my portfolio. I believe that will result in significant a tax hit. I do not think my wife and I will outlive our money. Guess there is a bit of inertia on my part.

Stanley P. | December 4, 2014 4:10 pm

We live comfortably on pension, annuity and social security. Dividends, cap gains and interest are pluses.Our RMD is reinvested into Vanguard’s balanced funds. I classify ourselves as conservative octogenarians but we remain open to Vanguard’s annual review of our selected investments . I currently believe the 65/35 approach is realistic given that one should stay in the market and ride up and down unless something goes haywire as what started in September ,2007.. A problem is how to determine what best goes into the 65%. The 35%is a Bonds no-brainer. International activity is not doing well contrary to the analysts suggesting a percentage of the portfolio in that direction. We expect good things to happen and we are staying the course. Naturally, we expect Vanguard to handle the helm and always steer us effectively, efficiently and with adaptability. We want the best. And we look forward with your help.

Rob B. | November 20, 2014 2:48 pm

I’m curious why the recommendation to rebalance continues to be once a year but only if the policy threshold has been exceeded by 5% (time-and-threshold method)? It’s a solid enough strategy based on historical analysis, but in Vanguard’s own work (Best Practices for Portfolio Rebalancing – July 2010), the average annualized return of a typical 60/40 portfolio rebalanced using the “threshold only” method (monitored monthly/quarterly/annually) results in similar returns but a much lower standard deviation than all the other rebalancing strategies analyzed in the paper, and therefore achieves a far more attractive Sharpe ratio (See Appendix B). What am I missing here?

Chris L. | November 17, 2014 2:17 pm

With rebalancing a portfolio being as important as it is, why doesn’t Vanguard provide an automatic rebalancer to use? I am exactly what you said, as I suffer from rebalaphobia. I want to but just not sure where to start.

Mark T. | December 5, 2014 10:11 am

Lee S. | December 31, 2014 3:20 pm

Vanguard’s LifeStrategy Funds may be what you are looking for. There are three levels: Income; Conservative Growth; Moderate Growth; Growth. Take your pick; they are all index funds and they Auto-Rebalance. May not be the best, but you won’t sweat rebalancing. My spouse and I are strongly considering going that way.

Matt K. | December 5, 2014 10:56 pm

I wholeheartedly agree. It takes ten times longer to rebalance when you have to manually transfer numbers to a separate spreadsheet and do the calculations yourself. My 401k through another firm offers this ability, why not Vanguard? Are they worried that people will rebalance too frequently, driving up costs?

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For more information about Vanguard funds, visit vanguard.com or call 877-662-7447 to obtain a prospectus or, if available, a summary prospectus. Investment objectives, risks, charges, expenses, and other important information about a fund are contained in the prospectus; read and consider it carefully before investing.

Vanguard ETF Shares are not redeemable with the issuing Fund other than in very large aggregations worth millions of dollars. Instead, investors must buy and sell Vanguard ETF Shares in the secondary market and hold those shares in a brokerage account. In doing so, the investor may incur brokerage commissions and may pay more than net asset value when buying and receive less than net asset value when selling.

Investments in bond funds are subject to interest rate, credit, and inflation risk.

Diversification does not ensure a profit or protect against a loss.

Investments in stocks or bonds issued by non-U.S. companies are subject to risks including country/regional risk and currency risk. Stocks of companies based in emerging markets are subject to national and regional political and economic risks and to the risk of currency fluctuations. These risks are especially high in emerging markets.

All investing is subject to risk, including the possible loss of the money you invest.